Should You Be Worried About Waters Corporation’s (NYSE:WAT) 3.0% Return On Equity?

Simply Wall St
December 4, 2018

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE).
To keep the lesson grounded in practicality, we’ll use ROE to better understand Waters Corporation (NYSE:WAT).

Our data shows Waters has a return on equity of 3.0% for the last year.
One way to conceptualize this, is that for each $1 of shareholders’ equity it has, the company made $0.030 in profit.

How Do You Calculate Return On Equity?

Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated.
It is the capital paid in by shareholders, plus any retained earnings.
Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does ROE Mean?

Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections).
The ‘return’ is the yearly profit.
That means that the higher the ROE, the more profitable the company is.
So, all else being equal, a high ROE is better than a low one.
That means it can be interesting to compare the ROE of different companies.

Does Waters Have A Good ROE?

By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is.
However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification.
As shown in the graphic below, Waters has a lower ROE than the average (11%) in the life sciences industry classification.

The Importance Of Debt To Return On Equity

Companies usually need to invest money to grow their profits.
The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing.
In the case of the first and second options, the ROE will reflect this use of cash, for growth.
In the latter case, the debt used for growth will improve returns, but won’t affect the total equity.
Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Waters’s Debt And Its 3.0% ROE

Although Waters does use debt, its debt to equity ratio of 0.61 is still low.
Its ROE is rather low, and it does use some debt, albeit not much. That’s not great to see.
Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

In Summary

Return on equity is useful for comparing the quality of different businesses.
In my book the highest quality companies have high return on equity, despite low debt.
If two companies have around the same level of debt to equity, and one has a higher ROE, I’d generally prefer the one with higher ROE.

But when a business is high quality, the market often bids it up to a price that reflects this.
The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too.
So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St is a financial technology startup focused on providing unbiased, high-quality research coverage on every listed company in the world. Our research team consists of equity analysts with a public, market-beating track record. Learn more about the team behind Simply Wall St.

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